Buying Investment Properties? Consider California

By Leonard Baron,

Published September 10, 2013

Zillow

Reuters

California can be a great state to park your long-term real estate investment dollars. Not only has the Golden State provided outsized wealth growth for real estate owners over the past 40 years, but going forward it has some unique characteristics that make it quite appealing to an investment property owner.

Now this isn’t to say that you can just blindly buy any old property in the state and build wealth. But if you do your homework you can find properties that make smart sense. Here’s why:

Proposition 13: Property tax limits

Back in the late 1970s Californians were tired of ever increasing property tax levies, so they passed a initiative that limited property taxes and property tax increases. When you buy any property in California, your regular property taxes are 1 percent of your purchase price. So on a $100,000 property you would pay $1,000 per year in regular property taxes (there may be additional county bond levies or Mello-Roos taxes). That original $1,000 amount can only increase a maximum of 2 percent per year, and it’s averaged about 1.5 percent since Prop 13 was passed. This is contrary to how the vast majority of states’ property taxes work. Most states’ taxes go up each year corresponding to increases in property values, so if your value soars, so do your taxes. But not in California, and that’s a big plus for real estate owners in the state.

Scarcity of valuable land

In most desirable metropolitan areas of the state, very little land is available for development within a reasonable distance from the main employment centers. For example, in San Diego, only a few big parcels are left within an hour drive of the city, and they are all under development. Fewer than 25,000 lots remain before all the land in the county is pretty much built out. So this restricted supply means prices for “dirt” and existing homes should increase over the long term. The major California cities or counties — San Francisco, Los Angeles and Orange County — are all in the same boat. Because of the scarcity of land, the prospects are good for value increases over time.

Difficulty of development, permitting, building

In addition to a lack of available land, it’s really tough to develop in California. It could be a group fighting the developer and demanding lower density of units on the parcel; a land owner wanting a fortune for his or her property; a city’s exorbitant impact and building permit fees; or the sky-high cost of construction materials and labor. These all hamper affordable housing, profitable development and increasing the housing stock. And again, this will restrict supply and most likely increase values of the current stock of property.

Population increases

If you watch TV, read the paper or surf the Internet, you are probably aware that the population of the U.S. is projected to increase during the next 50 years. And people seem to want to live in the coastal areas. So with the population expanding over future decades, and the desirable weather in the Golden State, it’s likely that California property prices will swell.

Those are the fundamentals, but again, you still need to make a smart purchase decision. Investors should target moderately priced properties that have positive cash flows, then manage their properties well and do their best to maximize profits and minimize hassles. If you do, the chances are good that your investment in some of the best dirt in the nation will help your retirement picture.

Final note of caution: California has high sales, income and use taxes, all of which should be factored into your overall financial decisions.